Redundancy packages and tax liability
Redundancy packages are unfortunately at the front of many minds at the moment, with many people asking “Will the taxman get his hands on any of my redundancy money?”
According to the Money Advice Service, this is one of the first questions people ask when facing redundancy. Well, for your information, your redundancy package pay element is compensation for your job loss and as such it qualifies for special tax treatment, with up to £30,000 being tax free.
However, other components in a redundancy package could be taxed as earnings.
If as part of the redundancy package, holiday pay, pay in lieu of notice, wages owing and bonus payments are due to you under your contract of employment, they do not count as tax-free redundancy pay.
So, Tax and National Insurance contributions will be deducted by HMRC as usual from these payments before you get them.
For example, if you received a redundancy payment of £18,000 plus one month’s pay of £1,000 in lieu of notice, for a total redundancy pay package of £19,000, the redundancy payment would be tax free, but your employer should have deducted tax and National Insurance contributions from the additional £1,000.
Any non-cash benefits that form part of your redundancy package, such as a company car or computer, will be given a cash value and added to your redundancy pay for tax purposes.
This may then take the redundancy payment over the £30,000 limit.
For example, you receive a redundancy lump sum of £30,000 and you get to keep your company car, which is valued at £10,000. The value of the car is added to the redundancy payment, making the package £40,000.
Only £30,000 is tax free, so you will pay tax on the remaining £10,000 which if you are a higher-rate taxpayer, is 40%, or £4,000!
When you get your redundancy pay, your employer will usually have deducted the tax but there is unfortunately a distinct probability they won’t have taken off the right amount.
So you may need to claim tax back or pay extra tax.
To avoid nasty aftershocks, it is best that you work out your tax liability in advance, roughly estimating what your redundancy package will be and taking into account what’s tax free and what isn’t.
Since the tax you pay depends on your income for the whole year, the calculations your employer makes when paying your redundancy money can never be exact.
Make sure you contact your tax office at the end of the tax year to check you haven’t overpaid or underpaid tax.
How much tax you pay is calculated on an annual basis.
So, if you’ve stopped working part way through the tax year, you might have paid too much.
Never assume your employer has got the calculations right.
The tax deducted could be too much or too little. It’s up to you to notify HM Revenue & Customs.
You may be asked to complete a Self Assessment tax return at the end of the tax year to pay any additional tax due.
A redundancy package is often not a good substitute for ongoing earnings.
Make sure that you recognise the value of the amount to you as if it was salary or wages – for how many months or years of living expenses will the single payment tide you over?
If you don’t need all your redundancy money to meet your living expenses, consider saving or paying off debts, or even contributing to your pension.
Paying into a pension plan can be a tax-efficient option. But tax and pensions are rarely straightforward, and remember there are limits as to how much you can pay in.
If you would like any further information relating to redundancy, starting up in business, calculating or paying your taxes or running a business as a limited company or a sole trader, please do contact the IN Team who will be happy to help.
To understand your rights regarding this subject, please have a look at HMRC’s guide on this subject here: https://www.gov.uk/redundancy-your-rights
You can calculate your redundancy pay here: https://www.gov.uk/calculate-your-redundancy-pay
If you are an employer and are considering making redundancies you can read more here about your responsibilities, due process and the cost of redundancy packages to your business: https://www.gov.uk/staff-redundant